Many Custom Core clients seek exposure to global markets by investing in individual constituents, allowing the same level of customization available in the highly accessible US markets. The two most common ways of doing so are foreign ordinary shares and American Depository Receipts (ADRs). We believe ADRs are a pragmatic choice for most global investors interested in Custom Core, since the administrative burden and asset levels required to build a portfolio of foreign ordinaries in close to 50 countries can be prohibitive. ADRs allow easier access to companies listed on foreign exchanges without requiring local market registration, making them a common choice for investors interested in global exposures such as MSCI ACWI or MSCI ACWI ex-US.
Within the context of global ADRs, investors should be aware of some country and sector coverage imperfections and trading-hour mismatches that lead to higher expected tracking error. Combining emerging markets (EM) with developed markets (DM) implemented with ADRs is an easier solution for most global investors. ADRs with sufficient liquidity cover approximately two-thirds of the MSCI ACWI ex-US Index by weight and one-quarter by issuer as of July 2020. Our research suggests a typical optimized ACWI ex-US ADR portfolio exhibits about 2% tracking error relative to the MSCI ACWI ex-US Index. Investors might be interested in stand-alone EM ADR implementation, but we would caution against this based on relatively light ADR coverage in the asset class.